Sunday, September 05, 2010

On a recent speaking tour, Admiral Michael Mullen, Chairman of the Joint Chiefs of Staff, told audiences, “The most significant threat to our national security is our debt.” His point was that a sound economy would be essential to provide the resources needed to maintain a strong defense. This, he believes, is threatened by the increasing interest burden of our national debt.

Admiral Mullen is rightly concerned. New government debt is rarely incurred to finance important, long-term capital investments. Most often it covers only transfers and current consumption. As a percentage of the budget, defense spending has fallen from over 50 percent in 1960, to just over 20 percent in recent times. Now, more than half the budget is taken up by Social Security, Medicare, other health-related spending, and the various income security programs.

Interest payments have hovered around 9 percent of the budget and will likely grow. The White House recently raised its forecast for the fiscal-2011 budget deficit to $1.4 trillion, which means that the total national debt is expected to increase by more than 10 percent. The debt-service burden will grow accordingly; and when interest rates start rising, the refinancing of maturing government debt will amplify that burden.

Increased debt burdens imply increased future tax burdens. In other words, given the low investment value of most government spending, the increased future tax burdens will not be justified by increased future production. That means we’ll come out with lower disposable incomes than we might have otherwise.

There are other, more subtle, factors that Admiral Mullen might have mentioned. The incidence of the various taxes diverts resources to second-best uses. Those uses are judged, not by their total returns, but by their after-tax returns. Politically favored activities will have lower tax rates and will attract more resources as a result.

The complexity of the tax system and the possibility of sudden changes add to the uncertainties of life and make personal and business planning more difficult and expensive. This effect is compounded by the uneven expansion of government spending programs and the kaleidoscopic regulatory system.

Our reactions to all these things in the course of earning a living are reflected in the relative prices of all the goods and services that we trade. Whether we know it or not, those prices and the quantities are full of information about what we want and what resources are available. The less interference we have in our trades, the better we all communicate and coordinate our business plans with each other.

As governments grow in size and influence, they tend to replace private decisions with political decisions. Incentives are changed, actions are influenced, and information is lost. We lose our natural means of deciding and agreeing how best to use most of our time and resources. We turn smart money into stupid money.

Those who have experienced life in a communist country know that as government takes over we become economically blind. Private knowledge and initiative are replaced by glorified guesswork called government “planning.”

There is an old Cold War joke about a Soviet general boasting at an embassy party: “We will conquer every country in the world!” A thoughtful pause, then the refinement: “Every country except New Zealand.” A bewildered westerner asks the obvious: “Why not New Zealand?” The suddenly sober general replies: “Well somebody has to set prices!”

Socialist systems are aided by the existence of market economies outside their borders. The market economies generate price and product information that the socialist planners can copy in their forlorn attempts to postpone the collapse of their systems.

The Soviet system did collapse, and perhaps their old general did learn a thing or two about economics. Old habits of state control die hard, but the new Russia is now somewhat freer and stronger. The personal income-tax rate in Russia is a flat 13 percent. Now there’s something that even we can copy.